An unusual, $500-million class-action lawsuit by tobacco farmers that accuses the federal and Ontario governments of turning a blind eye to contraband tobacco, seriously undermining the legal cigarette industry in the process, has hit a brick wall.

The farmers allege tax authorities chose to let the trade in unlicensed, untaxed tobacco flourish to avoid angering First Nations’ communities where the cigarettes are made and sold. It is a charge often levelled by anti-smoking and industry critics, too.

But Justice Duncan Grace has ruled even if the government did act to appease First Nations, it was a decision made for economic, social and political reasons, and cannot be challenged legally.

If governments had a duty to private individuals like the farmers in such cases, as opposed to the public, they would be vulnerable to unlimited lawsuits, said the Ontario Superior Court judge.

“Many industries are regulated. Most products are taxed,” he wrote in his decision, released this month.

“If a private law duty of care exists in this case, where does it end? It seems to me that the government [would be] exposed to the risk of suit by anyone disadvantaged by any decision made under a regulatory or taxing statute.”

The judge accepted an application by the provincial and federal governments to strike down the statement of claim that launched the class-action suit.

The tobacco producers have yet to decide whether to appeal the ruling, said John McDonald, one of their lawyers.

But he stressed the lack of enforcement action by federal and provincial officials has had dramatic effects, pointing to a 32-kilometre stretch of highway near the Six Nations’ community in southern Ontario that is lined with makeshift stores selling unlicensed tobacco.

“There are so many, you can’t even do an accurate count as you drive through,” he said. “If [governments] are doing something, it’s just sort of surface painting.”

Ronald Slaght, who represented the Department of National Revenue in the case, argued governments cannot be expected to universally enforce every aspect of every law.

“There aren’t unlimited resources to do everything in government, so there has to be a balance,” he said. “There is no policy of abandonment of [tobacco-tax] enforcement, but it is a difficult issue.”

The suit alleged Ottawa and Ontario allowed aboriginal tobacco producers and retailers to make and sell cigarettes without government licensing or paying excise taxes.

Many cigarettes are smuggled in from factories on the U.S. side of the Akwesasne reserve near Cornwall, Ont., but police say plants are also operating on at least three reserves in Canada.

Evidence suggests some of the raw tobacco they use is supplied illicitly by accredited Ontario tobacco farmers.

Contraband tobacco products have flooded the Canadian market, accounting for as many as 32% of cigarettes smoked nationally in 2008, though estimates for recent years have dropped somewhat, says the group Physicians for a Smoke-free Canada.

The federal government and the Royal Canadian Mounted Police have tried to combat the contraband problem, primarily through police action against smugglers, but critics say more could be done. That includes cracking down on the sale of raw tobacco, papers, filters and other ingredients to the contraband producers, and trying to close the unlicensed factories.

First Nations’ tobacco entrepreneurs and some leaders in their communities contend they have a sovereign right to produce and sell cigarettes outside the tax system. Any attempt to raid the facilities would be met with anger and stiff opposition, they say.

Regardless, the two Ontario tobacco farms named in the suit allege the declining market for legally produced tobacco has had a devastating effect. They say they sold less than 20,000 pounds of tobacco in 2008, down from 117,000 lbs. in 2001.